FYI: The Estate Planning “Game” – How the Rules Work

INTRO: The estate planning “game” is one every adult plays, but some play more actively and more intelligently than others. The challenge lies in understanding how all the rules work, and thus the optimal way to play. This can be pretty tricky and difficult without expert professional advice.

Sadly, if you lose this game, your loved ones usually suffer. Despite people’s best intentions, unintended consequences happen all too frequently, as described in the hypothetical examples below.

Family #1: Judy has two adult children, John and Jane. Judy’s primary assets are a $1 Million home, with no mortgage; and a $200,000 bank account.

Family #2: Bob has two adult children, Bill and Betty. Bob’s primary asset is his $1 Million 401K.

Relevant Facts: Judy and Bob each divorced their first spouses, have been happily married for 15 years and live in Judy’s home. They keep a small joint checking account for routine living expenses, but otherwise maintain separate assets.

Judy and Bob know that all responsible adults do Wills. Thinking they don’t need a lawyer, they download basic Will forms from the internet, and each sign one. Each Will states that on the death of the testator, all assets go to the testator’s children, in equal shares. It is simple and they are satisfied.

1) Judy takes out a home equity credit line on her home. In order to qualify, Bob’s income is needed. So Bob goes on title with Judy, as required by the lender. Their neighbor (who seems like a pretty smart guy) tells them that he and his wife hold title to their home as “joint tenants”, as do most married people. So, Judy and Bob tell their lender that they’ll take title as joint tenants.

2) In case anything ever happens suddenly to Judy, she wants one her children to have authority to access funds from her bank account. She thinks about adding both John and Jane to her account, but decides against that since the kids don’t get along well. So, Judy adds John as a signer.

3) Bob lists his children, Bill and Betty, as beneficiaries of his 401K so that they’ll receive the bulk of his assets.

Let’s explore the harsh unintended consequences on the death of Judy and on the death of Bob:

1) Judy’s $1 Million house. Joint tenancy carries with it the “right of survivorship” (“R.O.S.”), which trumps a Will. This means that at the death of one joint tenant, title vests fully in the name of the surviving joint tenant. Since Judy added Bob as a joint tenant she took out a home equity line, the R.O.S. feature results in Bob automatically becoming the sole legal owner of the house on Judy’s death. Even though John and Jane are in Judy’s Will to receive all of her assets, they receive no interest whatsoever in their mother’s house.

2) Judy’s $200,000 bank account. Judy didn’t understand that adding John as a signer meant that he would be the legal co-owner of this account. She also didn’t know that she could have instead established a Power of Attorney to give him access to the account if she became incapacitated. Even though Judy’s Will provides that John and Jane are to share equally in all of Judy’s assets, the joint account acts the same as a joint tenancy – on Judy’s death, John becomes the sole account owner. Though Judy wants each of her children to receive $100,000 from the account, John is entitled to all $200,000. John dislikes his sister, so when he becomes the legal owner of the account, he doesn’t feel any obligation to share half, or any at all, with Jane.

3) Bob’s $1 Million 401K. ERISA (federal law governing 401K plans) dictates that the spouse of a 401K owner has rights to it on the death of the plan participant, regardless of what the beneficiary designation states. If Judy had signed a written waiver, formally consenting to Bob designating his kids as the beneficiaries, Bill and Betty would each receive half of Bob’s 401K on his death, as he intended and as set forth on the beneficiary designation on file with the custodian. But no such waiver is on file, so Judy is automatically entitled to 50% of it.

It would not have required a large investment nor been difficult for Judy and Bob to obtain legal advice from an experienced estate planning attorney. Had they done so, they would not have made the innocent, but damaging mistakes they made.

This article is intended to provide information of a general nature, and should not be relied upon as legal, tax, financial and/or business advice. Readers should obtain and rely upon specific advice only from their own qualified professional advisors. This communication is not intended or written to be used, for the purpose of: i) avoiding penalties under the Internal Revenue Code; or ii) promoting, marketing, or recommending to another party any matters addressed herein.

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